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A Comparison of Japan and the United States

Steven N. Kaplan

Journal of Political Economy, 1994

Executive Summary:

This paper provides a comparison of the executive turnover and compensation sensitivity to firm performance at US and Japanese firms. While US managers receive more compensation than their Japanese counterparts, the same basic sensitivities are largely similar. Much of the paper is devoted to the differences. Japanese boards weight poor profit numbers more heavily in both the compensation and turnover arenas. This, and lower executive ownership suggest that bank monitoring is more important in Japan than in the US.

There is a debate over whether the Japanese or US corporate governance structure is "better." Many researchers have documented to the differences between US and Japanese firms and their corporate control. On one side, Japanese firms have closer ties with their suppliers and customers, more bank lending, and more cross-holdings. As a result Japanese firms are less influenced by the external takeover market. Some (notably Blinder 1991 and 1992, Abegglen 1985, and Milgrom and Roberts 1992) claim that this insulation allows managers to pay less attention to shareholders interests and place more importance on growth and market share.

"In contrast, others view the Japanese governance system as one that maximizes firm value. Grundfest (1990, p98)…argues that the close financial ties and relationships in Japan 'reduce agency costs and allow investors to monitor managers more effectively.'"

"A third view, associated with Aoki (1990) and Kester (1991) argues that Japanese managers must earn enough…to satisfy their banks and meet debt payments. Conditional on earning a satisfactory profit, however, managers can run their firms in the interest of employees or themselves."

To investigate these issues Kaplan looks at CEO pay and turnover. (Note the implicit assumption that the Board of Directors sets pay and punishments with the overall goals of the firm in mind.)

Data:

119 Japanese firms that were listed in Fortune's list of 500largest foreign industrials

146 US firms that were listed in Fortune's list of the 500 largest industrials

Table 1 presents summary statistics.

Notable from the table are that Japanese firms had much higher insider board makeup, the CEO had been with the company for a longer time, and US firms were much more likely to be taken over.

Interesting side note: Earnings were lower at Japanese firms but this is likely the result of only one set of books in Japan (so take all deductions) as well as differences in reporting of subsidiary incomes. (French and Poterba 1991) report that these lead to differences of between 41-77%

Comparison of Board of Directors

There are differences in Boards of the two countries. In Japan, the most powerful person is the president (shacho). Further board members are usually elected to 2 year terms vs. 1-3 in US. More importantly, Japanese boards usually are larger (median 21 vs. 15 in US) and most Japanese firms have no outside members (US firms in study had 9 outsiders).

Top Executives

The tops executive of the US firms was younger (59 vs. 66), had worked at the same firm for a shorter time (28 vs. 39 years), and has a slightly longer at the top (median of 5 vs. 4.3 years).

Turnover

Ignoring "turnovers caused by death, illness, or takeover," top executive and board turnover at Japanese firms is higher than at US firms.

The authors then regress top executive turnover of a series of performance variables. "To a large extent, the turnover-performance relations are economically and statistically similar in Japan and the United States." The main difference is that "turnover in Japan is most closely related to negative earnings. This result is not consistent with Japanese firms and management being able to ignore short-term earnings or cash flows. It is, however, consistent with…governance mechanisms becoming particularly active when companies have difficulties in generating cash flow and, possibly, meeting fixed obligations."

Most studies (Abowd and Bognanno 1993, Kato and Rockel) show that US top executives are paid more than Japanese counterparts. In this paper Kaplan looks at Board pay. He finds that US board members were paid substantially more (approximately 5x's as high!) (US Board members made $344,000 each). To compare this to Japanese firms (for which he only had the total board compensation) he used a multiple of average board member pay to the average wage of a worker in that country. US board pay was 13.5x's vs. 4.8x's in Japan.

The paper also looks at ownership data and finds that "the top Japanese executive…typically holds roughly one-half the ownership stake typically held by the top US top executive when only shares are considered and roughly one-quarter when options are included as well." The author presents the caveat however, that "these holdings are not particularly small relative to their compensation related wealth."